THE HEDGEYE DAILY OUTLOOK

TODAY’S S&P 500 SET-UP - October 11, 2011

Levels matter and ASIA looks more bearish in the majors (HK, Nikkei, KOSPI, etc) than Germany, France, and Italy do right now – that’s telling you something about Global Growth that is ringing in the -1.1% and -2.7% selloffs in oil/copper this morning that should be respected. Every stock market in Asia and every major commodity has failed at TRADE resistance.

As we look at today’s set up for the S&P 500, the range is 31 points or -2.23% downside to 1167 and 0.26% upside to 1198.

SECTOR AND GLOBAL PERFORMANCE

EQUITY SENTIMENT:

ADVANCE/DECLINE LINE: 2530 (-1218)

VOLUME: NYSE 888.12 (-22%)

VIX: 33.02 -8.8% YTD PERFORMANCE: +86.03%

SPX PUT/CALL RATIO: 2.24 from 2.54 (-11.80%)

CREDIT/ECONOMIC MARKET LOOK:

From KM - US TREASURIES: very interesting action on the short end of the curve continues to develop w/ 2-year yields having broken out above my TRADE line of 0.21% and now testing my TREND line up at 0.30%. I expect short-term yields to back off here, but the short end of the curve should continue to pressure the Gold price (which failed again at $1678 TREND resistance)

EURO – yesterday KM put up the $1.36 line in the sand and said short the Euro with “impunity” there.

EUROPEAN MARKETS

ASIAN MARKETS

MIDDLE EAST

Howard Penney

Managing Director

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10/11/11 08:00 AM EDT

Barroso's Bazooka

This note was originally published
at 8am on October 06, 2011.
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“I don’t have to be careful, I’ve got a gun.”

-Matt Groening

It’s only a matter of time before the likes of Jon Stewart and Matt Groening (creator of The Simpsons) start mocking this European Gong Show for what it has become – a gong show.

Groening made his debut in Wet Magazine in 1978 with a cartoon called “Life in Hell.” That might be a better way to describe how a money manager feels about dealing with La Bernank et Le Trichet’s concepts of Keynesian “price stability.” Today’s game of Globally Interconnected Risk is being driven by rumors of Barroso’s Bazooka.

Does Jose Manuel Barroso (President of the European Commission) have a bazooka? What’s the timing on its deployment? Who supports it? Oh the drama…

What we do know is that the IMF, ECB, EU, and Timmy Geithner are working on it, feverishly. These are the said leaders of our lives who are going to centrally plan our way to long-term prosperity. What would we do without them?

On the topic of the bazooka, this is what Geithner had to say yesterday:

“Europe needs a more powerful financial backstop.”

This, of course, comes on the heels of Christine Madeleine Odette Lagarde saying she (or the 187 countries she now represents on behalf of France and The DSK at the IMF) has ze “infinite resources” to print ze ammo for Le Bazooka.

Or is it La Bazooka?

Maman, pardon mon francais, but this is what a Yale education has reduced me to. I’m now just a man with a keyboard and a tweet machine fighting the Socialists of the world who are putting another bailout gun to capitalism’s head.

Back to the Global Macro Grind…

With the SP500 up +4.1% from its Monday closing low of 1099, the pain being felt in the hedge fund community is much greater than that.

You see, if you shorted the immediate-term TRADE oversold bottom (Tuesday morning) of 1078, and you’re staring down the crosshairs of the S&P Futures indicated up another 10 handles this morning, you are feeling the bazooka of the Pain Trade yourself.

Obviously whoever shorted the low instead of seeing it for what it was – a Short Covering Opportunity – does not Occupy Hedgeye as part of their risk management process. Shorting low and covering high isn’t cool.

So what do we do now?

The thing about this Barroso Bazooka is that it’s real. Weeks ago we did a 52-slide presentation outlining what the size of the bazooka could be and we’ll go over this again for clients on our Q4 Macro Themes Call next Friday (email sales@hedgeye if you want in), but here’s our headline math (slide 42):

1.25-1.75 TRILLION Euros to Recapitalize European Banks

0.75-1.25 TRILLION Euros to Fund Future Deficits

= 2-3 TRILLION Euro-TARP Bazooka

Now, to be clear, as our Director of Research, Big Alberta, often reminds me – size matters. But there are still some other things about this bazooka to consider:

Timing – there is no timing. That’s a problem.

Coordination – to deploy a bazooka that big, herding politicians of the world will be like herding cats.

Markets – remain real-time. Tick tock.

So… on with our risk management day.

Instead of sending our Senior European analyst, Matt Hedrick, back to France to pose as one of two-eggs-side-by-each on Lagarde’s breakfast meeting plate, the best we can do is let Mr. Macro Market tell us what to do.

The German DAX is breaking out above our immediate-term TRADE line of resistance (5439) again this morning. So the 1stthing we do is don’t short European Equities. Wait and watch.

The 2ndthing we do is watch the Euro/USD currency pair. If the Euro can close above $1.34, then the short squeeze in almost everything inversely-correlated to the US Dollar can continue (EUR/USD drives USD Index). If the Dutch come out intraday and vote down the size of Barosso’s Bazooka (and the Euro fails again at $1.34), there is no support all the way back down to its 2011 lows of $1.29-1.30.

In the end, like you are seeing with US money-center banks post the 2008 Geithner/Paulson TARP1 Bazooka, there will be an end … and piling more short-term debt-upon-debt on insolvent banks and their incompetent political advisors will end badly. Very badly.

But, back to the immediate-term, if you’re not the one with the gun – things can end badly for the pig-headed short seller too.

My immediate-term support and resistance ranged for Gold, Oil, the German DAX, and the SP500 are now $1601-1673, $75.86-84.59, 5439-5767, and 1099-1172, respectively. On Tuesday morning, I cut our Cash position from 73% down to 67%, taking our asset allocation to US Equities up to 6% (versus 0% at this time last week).

CHART OF THE DAY: Groupthink's Behavior

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Groupthink's Behavior

When our head of Healthcare Research, Tom Tobin, and I were working at what used to be called Dawson-Samberg (long-time hedge fund that split up) over a decade ago, we were learning what Wall Street “consensus” was by doing. Today, we continue to develop processes to quantify it. This, like any good process, takes flexibility, testing, and time.

Within the context of a long time, “groupthink” is a relatively new phenomena. Irving Janis’ original groupthink research at Yale University didn’t occur until the early 1970s. Since then, it’s been very helpful in analyzing both the military and economic policy mistakes of central planners.

Groupthink can also be applied to analyzing the behavior of short sellers – as in hedge funds – and how and when they make decisions. To be, or not to be hedged – remains the question. With the most obvious of groupthink occurring at the most painful ends of what we call the immediate-term TRADE range.

While it’s hard to believe that Old Wall Street missed making the 2011 Growth Slowing call (after having had the opportunity to review their 2008 forecasting mistakes), it’s even harder to believe that the SP500 can put on a 116 point (+10.7%) move in less than a week and still have so many hedge fund guys trafficking in the same high-short interest hedges.

Believe both.

I remember listening to a friend explain to me that John Paulson was “reducing his exposure to 62% net long” (with leverage) sometime back in early Q3 of 2011 and thinking to myself, that’s not a hedge fund – hedge funds hedge.

But that was just silly young me saying what any prudent Risk Manager should have said about Paulson’s positioning, given my bearish intermediate-term Global Macro view.

After I said it publically on CNBC again in July, I had people do the proactively predictable and tell me I was being whatever they call someone when they are confident in their view. After all, John Paulson is smart. But, then again, so is my team. Market opinions aren’t personal. Neither are the tail risks associated with redemptions and liquidations. It’s all part of the game.

Back to the Global Macro Grind…

With the Short Covering Opportunity and the Eurocrat BazookaSqueezes out of the way, now we can get back to managing risk around newly developed ranges. In the last week, a very important signal has developed on my immediate-term TRADE duration that supports that claim – the SP500 and Volatility have recovered their respective TRADE lines of support and resistance.

What does that mean? First, let’s look at the levels.

SP500 TRADE line support = 1167 and TREND line resistance = 1228

Volatility (VIX) TRADE line resistance = 36.91 and TREND line support = 29.02

Did I just confuse the matter by throwing in another duration (the intermediate-term TREND)? Yes, I did. And that’s the risk management point that we continue to beat the drums on within our process – you have to be able to be Duration Agnostic.

What that means is that bullish is as bullish does for US Equities provided that the TRADE line of 1167 holds. But only to a point (the TREND line of 1228). And with a deep respect for that point, we also have to wake up every morning Embracing Uncertainty – because the minute that 1167 breaks again, we’ll need to be focused on putting our crash helmets back on.

This Globally Interconnected Game of Risk can get even more confusing if you don’t blow out your model to absorbing the uncertainty associated with correlation risks across global markets. Whether they be countries, currencies, or commodities, they’re all there – and they affect Groupthink’s Behavior, big time.

We call that being Multi-Factor in our risk management approach.

So, with a multi-factor (countries, currencies, commodities, etc.), multi-duration (TRADE, TREND, and TAIL) Global Macro model in hand, what do I see going on out there this morning?

Here’s my Top 6:

SP500 bullish TRADE; bearish TREND

VIX bearish TRADE; bullish TREND

Hang Seng in a Bearish Formation (bearish across all 3 durations, TRADE/TREND/TAIL)

Copper and Oil in Bearish Formations

Euro/USD cross in a Bearish Formation with TRADE and TAIL lines of resistance at $1.36 and $1.39, respectively

German DAX bullish TRADE; bearish TREND

I have a lot more than 6 factors in my model – but these are the ones ringing with the most Correlation Risk right here and now. These are my front-runners for managing Global Macro risk.

I have a tremendous amount of confidence in both my risk management model and the 41 people on my team that support its inputs. This confidence is a culture – we are not too proud to change the model’s parameters or throw away the wrong assumptions when they are not working. As prices, volatilities, and volumes change, we do.

Embracing Uncertainty is the furthest thing from what Old Wall Street wants right now. The only certainty I have about that is that Groupthink’s Behavior is going to continue to have performance problems as these markets churn.

My immediate-term support and resistance ranges for Gold, Oil, the German DAX, and the SP500 are now $1, $80.90-86.41, 5, and 1167-1198, respectively.

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